GETTING OUT OF DEFLATION AN EXPERIENCE OF UNCONVENTIONAL MONETARY POLICY 1 Bank of Japan Shinichi Uchida
Prologue (1990) 2
IN 1990 I was an LLM Student at HLS. 3
600 CY 1980=100 AT THAT TIME Japan was at the peak of Bubble Economy. The land prices and stock prices more than tripled. You can buy all lands of the USA in exchange of Tokyo 500 400 Stock prices Land prices 300 200 100 0 CY 80 81 82 83 84 85 86 87 88 89 90 Sources: Bloomberg; Ministry of Land, Infrastructure, Transport and Tourism. 4
BUT Bubble economy collapsed in early 1990s. The economy slowed down and the land prices and stock prices dropped sharply. 600 500 400 CY 1980=100 Stock prices Land prices 300 200 100 0 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 CY 5 Sources: Bloomberg; Ministry of Land, Infrastructure, Transport and Tourism.
THEN Banks balance sheets were deteriorated: nonperforming loan problem Some large commercial and investment banks failed in 1997 and 1998: financial crisis 4 % 3 2 1 Credit cost ratio 0 FY 90 91 92 93 94 95 96 97 98 99 00 01 02 03 6 Source: Bank of Japan.
Chapter 1 Era of Deflation (1998- ) 7
15 YEARS OF DEFLATION STARTED Coupled with the slowdown of economic growth and financial system problems, inflation rate became negative in 1998. 15 years of deflation started. 5 y/y % chg. 4 3 CPI 2 1 0-1 -2 CY 90 91 92 93 94 95 96 97 98 99 00 8 Source: Ministry of Internal Affairs and Communications.
FOOTNOTE: IS DEFLATION A PROBLEM? It is easy to understand that inflation is a problem. Under 10% inflation, you have to pay $110 to buy a book you could buy at $100 last year. Value of your $ 100 bill declines by 10% every year. It s a problem 9
FOOTNOTE: IS DEFLATION A PROBLEM? But, Under deflation, you can buy the book at $90. Is it a problem? Yes, it is a problem for Book Store, Author of the Book, Bank which lent money to the Book Store.. 10
EPISODE OF DEFLATION - 1 The Great Depression (1929-34) 6 y/y % chg. 4 2 0-2 -4-6 Unemployment rate 25% -8 CPI -10-10% deflation -12 CY 29 30 31 32 33 34 35 36 37 38 39 11 Source: Bureau of Labor Statistics.
6 4 2 0-2 -4-6 -8-10 -12 CY EPISODE OF DEFLATION - 2 Japan (1998- ) y/y % chg. CPI average inflation rate - 0.2% (1998-2012) 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 12 Source: Ministry of Internal Affairs and Communications.
THE GREAT DEPRESSION VS. JAPAN S DEFLATION The Great Depression: sharp decline in prices in a very short period Japan s Deflation: mild but very persistent decline in prices 13
WHAT HAPPENED IN 15 YEARS OF DEFLATION? Companies stopped investing and held cash & deposit 180 170 s.a., tril.yen Cash and bank deposits (left scale) Business fixed investment (right scale) s.a., tril.yen 16 15 160 14 150 13 140 12 130 11 120 10 110 9 100 8 14 CY 90 92 94 96 98 00 02 04 06 08 10 12 1415 Source: Ministry of Finance.
WHAT HAPPENED IN 15 YEARS OF DEFLATION? 6 Household accepted wage decline in exchange for job security %, y/y % chg 4 2 0-2 -4 Unemployment rate Nominal wage -6 CY 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 15 Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare.
WHAT HAPPENED IN 15 YEARS OF DEFLATION? Government spent more 3 2 1 0-1 -2-3 -4-5 -6-7 -8-9 -10-11 CY % of GDP Deficit 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 16 Source: OECD.
WHAT HAPPENED IN 15 YEARS OF DEFLATION? Banks bought government bonds 1,400 1,300 1,200 1,100 1,000 900 800 700 600 500 FY tril.yen Loans Deposits 90 92 94 96 98 00 02 04 06 08 10 12 14 Source: Bank of Japan. Government bonds 17
WHAT HAPPENED IN 15 YEARS OF DEFLATION? Is it all right? No, it is not sustainable. Slow economic growth, decline in wage and prices, more fiscal deficit and bad environment for bank s profitability So we have to change! 18
Chapter 2 Battle with Deflation #1 (1998-2007) 19
ZERO INTEREST RATE POLICY (1999-2000) To stop deflation, the Bank of Japan cut the interest rate. The policy rate (overnight rate) became 0% in 1999. 9 % 8 7 6 Overnight rate 5 4 3 2 1 0 CY 90 91 92 93 94 95 96 97 98 99 00 20 Source: Bank of Japan.
FOOTNOTE: CONVENTIONAL MONETARY POLICY Usually a central bank raises or cuts interest rate to stabilize economy and inflation. If economy slows and inflation rate drops, central bank cuts interest rate. Companies can borrow money cheaper, and buy more machines. Consumers can borrow money and buy more cars and houses. Stimulate economy and prices. 21
QUANTITATIVE EASING (2001-2006) Interest rate was already 0% and the Bank of Japan can not cut the rate. So the Bank introduced the first Unconventional Policy: QE Increase the volume of money BoJ provided more money to financial institutions. (effective for preventing bank runs, but the effects on the economy was unclear) Promise to keep 0% for some time BoJ promised to continue QE until CPI become 0% or higher. (Long-term interest rates dropped, which boosted the economy) 22
RESTORE SOUNDNESS OF BANKING SYSTEM In addition to monetary policy measures, the government and the BoJ introduced several prudential policy measures. Capital injection to banks By the Bank of Japan: 0.2 trillion yen (1995-2004) By the Government: 10.4 trillion yen (1998-2003) The Bank of Japan bought stocks from financial institutions (2002). 23
RESTORE SOUNDNESS OF BANKING SYSTEM By mid-2000s, non-performing loan problem was over and Japanese banks became healthy. 10 % 9 8 Nonperforming-loan ratio 7 6 5 4 3 2 1 FY 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 24 Source: Bank of Japan.
IN 2006-07, Consumer price index (CPI) became positive. We thought deflation will end soon. But. 2 y/y % chg. CPI 1 0-1 -2 98 99 00 01 02 03 04 05 06 07 CY 25 Source: Ministry of Internal Affairs and Communications.
GLOBAL FINANCIAL CRISIS IN 2008 Subprime loan problems in US Lehman Brothers failed in September 2008 While Japanese banking system kept soundness, Japan s economy was hit by the contract of world economy and sharp appreciation of the yen. Deflation continued. 26
Chapter 3 Battle with Deflation #2 <after the global financial crisis> (2008-) 27
CENTRAL BANKS INTRODUCED UNCONVENTIONAL POLICIES Central banks acted quickly to address global financial crisis (learning from Japan s bitter experience). Federal Reserve introduced QE in 2008. Larger scale than the BoJ s QE (2001-06). Buy long-term government bond to push down longterm interest rates directly. 28
INTRODUCTION OF QQE (2013) In April 2013, the Bank of Japan introduced Quantitative and Qualitative Monetary Easing QQE. Commit to achieve 2% price stability target strongly Provide money very aggressively Purchase government bonds in large scale This is the largest monetary easing ever in the history of central banks. Bank of Japan s balance sheet more than doubled. The Bank holds more than 30% of total government bonds. 29
HOW QQE WORKS Massive Bond Purchases Clear Commitment to achieve 2%CPI nominal interest rates-inflation expectations = real interest rates boost economy and inflation To stimulate the economy, real interest rate is important. 30
FOOTNOTE: TO STIMULATE THE ECONOMY, REAL INTEREST RATE IS IMPORTANT. Suppose you are a producer of toys. You have to decide whether you buy a machine to produce 1000 toys in one year. It costs $100 thousands. A bank offers you a loan (interest rate 2%). You can sell the toy at $100 now. Case 1 (3% inflation): When you think you can sell the toys at $103 next year, you should buy the machine. You will earn $103k and pay $102 k to the bank. So net profit is $1k. Case 2 (3% deflation): If you think you can sell it at $97 next year, you should not. You will lose $5k. In Case 1, 2% nominal interest rate is low enough for you (real interest rate is -1%), but in Case 2, too high. 31
HOW QQE WORKS Massive Bond Purchases Clear Commitment to achieve 2%CPI nominal interest rates-inflation expectations = real interest rates boost economy and inflation Long-term interest rates (10-year yields of JGB) Inflation expectations (ESP Forecasts: 7-11y ahead) Before QQE 0.7% (2013/1Q) 1.0% (2012/Dec) Now Real Interest Rate -0.3% -1.2% 0.2% (2016/Jan) 1.4% (2015/Dec) 32 about 1% decline
UNDER QQE: ECONOMIC ACTIVITIES Corporate sector is enjoying record profits. Unemployment rate is 3.3% = full employment. 20 s.a., tril. yen 6 s.a., % 18 16 14 5 12 10 8 4 6 Corporate profits 4 2 CY 05 06 07 08 09 10 11 12 13 14 15 Unemployment rate 3 CY 05 06 07 08 09 10 11 12 13 14 15 33 Note: Figures for corporate profits exclude those for the finance and insurance industries. Sources: Ministry of Finance; Ministry of Internal Affairs and Communications.
UNDER QQE: PRICES CPI became positive but less than 2%. Effects of a decline in oil prices 3 y/y % chg. 2 1 Introduction of QQE 0-1 CPI (all items) -2 CPI (all items less fresh food and energy) -3 CY 10 11 12 13 14 15 34 Source: Ministry of Internal Affairs and Communications.
QQE WITH A NEGATIVE INTEREST RATE To achieve 2% inflation, the Bank introduced QQE with a Negative Interest Rate last month. Apply a negative interest rate of minus 0.1 % to current accounts that financial institutions hold at the Bank of Japan. (charge 0.1% fees) Push down the interest rate more. 35
FOOTNOTE: WHAT IS A NEGATIVE INTEREST RATE? Usually, you have to pay money to the bank if you borrow student loans. And you will get some money if you deposit to the bank. In Japan, financial institutions have to pay money when they deposit to the BoJ. This will not happen between a bank and its customers. They will withdraw and hold cash. But possible between a central bank and banks. Holding huge amount of cash costs a lot. Only small negative: largest negative rate is minus 1.25 % in Sweden. 36
INTEREST RATES AFTER THE INTRODUCTION OF A NEGATIVE INTEREST RATE Before the introduction of NIR Now Current account at the BoJ +0.1% -0.1% Markets O/N interbank 0.074% -0.008% 5Y JGB 0.02% -0.16% 10Y JGB 0.23% 0.01% Banks Bank lending rate 0.9% will be lower Bank deposit rate For retail 0.02% NIR unlikely For corporate nealy 0% become negative? 37
FOOTNOTE: WHY 2%? Why does the Bank of Japan try to achieve 2%, rather than 0%? Global standard: US: 2% Europe: below but close to 2% Price index has some positive statistical bias. To avoid deflation, small positive inflation is better than zero inflation. 38
WHAT A CENTRAL BANK CAN DO, AFTER IT LOWERED ITS POLICY RATE TO 0%? Push down long-term interest rate: Japan, US by commitment to continue 0% by purchase of long-term bonds Negative interest rate: Denmark, Sweden, Switzerland, Euro, Japan by imposing fees on the accounts of financial institutions Push up inflation expectations: Japan by strong commitment to achieve 2% target 39
COSTS & RISKS OF QQE Potential moral hazard of fiscal policy Market function weakened Squeeze banks profits Hard to exit Benefits > Costs & Risks 40
Epilogue Is it only Japan? 41
JAPAN S EXPERIENCE Burst of bubble (early 1990s) 1. Deleveraging : financial system problems & balance sheet adjustment of corporate sector (finished by mid-2000s) 2. Confidence Crisis: widespread deflationary mindset (eased but still remains) Weak economic growth and prolonged deflation 42
US CASE Burst of bubble (2008) 1. Deleveraging : financial system problems & debt overhang of household (almost finished) 2. Confidence Crisis: weak capital investments and wages (still remains) Weak economic growth trend 43
EURO CASE Burst of bubble (2008) 1. Deleveraging : credit crunch & sovereign debt problem (still hot issue) 2. Confidence Crisis: from now? Fear of deflation 44
IS IT ONLY JAPAN? Labor Productivity 6 5 4 y/y % chg. Burst of bubble (Japan) Global financial crisis Japan United States United Kingdom 6 5 4 y/y % chg. Global financial crisis Germany France Italy 3 3 2 2 1 1 0 0-1 CY 71 76 81 86 91 96 01 06 11 14-1 CY 71 76 81 86 91 96 01 06 11 14 45 Source: OECD.
CONCLUDING REMARKS Japan is getting out of its 15 years of deflation by the Bank of Japan s extraordinary policy measure, QQE. We have tried and will try everything. 46
CONCLUDING REMARKS Lesson1: Avoid deflation. Once trapped, it costs a lot. Lesson2: Promise to do whatever the central bank can do, to make people believe that the deflation will be over. Lesson3: Burst of financial bubble may cause deleveraging, lack of confidence, slow growth and deflation. Good luck to Europe & US. 47